In the world of professional trading, there is a saying: "The crowd is usually right in the middle of a trend, but always wrong at both ends." If you can measure the "extreme" greed or fear of the crowd, you can predict when the market is about to reverse. The Put-Call Ratio (PCR) is the most powerful tool for this purpose.
As we saw in the Option Chain module, options data provides a window into the collective bets of all traders. While individual strikes show support and resistance, the PCR summarizes the entire market's mood into a single number.
Sentiment Speedometer
1. What is PCR? (The Math)
The PCR is a simple ratio of the number of Put options traded vs. the number of Call options traded. There are two ways to calculate it, but the Open Interest (OI) based PCR is the one most used by professionals.
PCR (OI) = Total Put Open Interest / Total Call Open Interest
If there are 1,00,000 Puts open and 80,000 Calls open, the PCR is 1.25. If there are 50,000 Puts and 1,00,000 Calls, the PCR is 0.50.
2. The Seller’s Perspective: Why PCR is different
To understand PCR, you must remember the rule from Module 08: Think like an Option Seller.
- A High PCR (> 1.0) means there are more Puts than Calls. From a seller's perspective, this means Big Players are selling (writing) Puts. They are confident the market will not fall. Therefore, a high PCR is generally Bullish.
- A Low PCR (< 1.0) means there are more Calls than Puts. Sellers are writing Calls, betting the market will not rise. Therefore, a low PCR is generally Bearish.
3. Decoding PCR Values
While the direction is important, the "extremes" are where the real money is made. This is called Contrarian Analysis.
| PCR Range | Market Sentiment | Interpretation |
|---|---|---|
| 0.50 - 0.70 | Extremely Bearish | Oversold: Everyone is scared and buying/selling calls. A sharp upward reversal is likely. |
| 0.80 - 1.00 | Bearish to Neutral | The market is trending lower or consolidating with a negative bias. |
| 1.00 - 1.20 | Neutral to Bullish | The market is in a healthy uptrend or consolidating with a positive bias. |
| 1.30 - 1.60+ | Extremely Bullish | Overbought: Everyone is greedy and selling puts. A sharp downward correction is likely. |
4. PCR Divergence: The Secret Signal
Sometimes, the price of Nifty goes up, but the PCR starts falling. This is called a Divergence. It means that even though the price is rising, big traders are starting to write more Calls than Puts. They are losing confidence in the rally. This is often a precursor to a market crash.
Similarly, if the market is falling but the PCR starts rising, it means "Smart Money" is starting to write Puts at lower levels, expecting a bottom. Following the PCR trend is often more reliable than following the price alone.
5. PCR and Mean Reversion
The PCR is a "Mean Reverting" indicator. It cannot stay at 1.8 or 0.4 forever. Whenever it hits these extremes, it eventually pulls back toward the average (around 1.0).
Professional traders use this to their advantage. If Nifty is hitting a resistance level and the PCR is at 1.7, the probability of a successful "breakout" is very low. It is much more likely that the market will "mean revert" and fall.
On the day of expiry, PCR values can become very volatile and misleading because traders are closing positions in the current week and moving to the next week. Always look at the Next Month's PCR during the expiry week to get a true sense of the long-term trend.
Summary of Module 09
- PCR is Put Open Interest divided by Call Open Interest.
- High PCR (>1.3) suggests an overbought market (Be careful).
- Low PCR (<0.7) suggests an oversold market (Look for buying opportunities).
- Always use PCR as a confirmation tool alongside Support and Resistance levels.
- Watch for PCR Divergence to spot early trend reversals.
We have now mastered the data, the sentiment, and the mechanics of the market. Only one piece of the puzzle remains: The Greeks. These are the mathematical variables that determine exactly how much your option price will change for every move in the stock. In our final module, we master Option Greeks.